Cash Flow Alert: How to Avoid Bad Debts

outstanding invoices

Business owners should do everything they can to avoid bad debts.

Bad debt is not just part of doing business. Lots of people think that having clients who don’t pay their bills is just part of doing business. Not so!

Bad debts are bad news. They need to be avoided. They cost you much more than the face value of the invoices.

What is a Bad Debt?

A bad debt is an unpaid invoice that will never be recovered.

If a customer refuses to pay you or goes out of business owing you money, then your unpaid invoice turns into a bad debt. You’ve lost that money forever.

Losing money is the last thing you can afford to do as a small business owner.

As a small business owner, you’ll already know how crucial it is to have a healthy cash flow. To keep your cash flowing, you need to find ways to avoid bad debts.

What Does a Bad Debt Really Cost You?

Here’s an example of how to work out what a bad debt really costs you:

  • Bad debt amount $1000.
  • Profit margin 5% (for every $100 of sales, you make a profit of $5).
  • The amount of new business required to cover the $1000 debt is $20,000.

So, to recover the money you’ve lost with the $1000 bad debt, you’ll have to find new business of $20,000.

In a small business, if you don’t get an invoice paid, that bad debt can make a massive dent in your profits.

Too many bad debts and lack of profits and your business will not survive. You will be one of the 44% who have to close their doors every year because they run out of cash.

Collecting prompt payment for your invoices and avoiding paid debts is key. The longer your invoice is unpaid, the more likely you will never be paid at all.

Choose Your Customers Carefully

One of the ways to avoid the chance of bad debts is by making sure your customers have a good track record of paying their other suppliers. This is called ‘credit checking’.

As the owner of a private business, you can choose who you’ll you do business with – so choose carefully. Choose clients that pay their other suppliers on time so you avoid bad debts.

Credit Checking: What Works

For my business, strong cash flow was paramount. We paid out $250,000 each Friday. We always had to have that money ready in our bank account.

Here’s how we ‘credit checked’ new customers to try and avoid bad debts:

  • Before we accepted an order, we checked to see if our potential new customer was a valid company.
  • We asked new clients (as soon as they gave as an order, but before we did any work for them), to give us contact details of five of their existing suppliers. Then we called those suppliers to confirm our potential new customer paid their bills on time.
  • If the feedback was that they paid late, or argued about the bill, we’d have to make a decision about whether if we would supply them (and risk not getting our invoice paid).
  • If for some reason, we wanted to supply and trade with the customer regardless, we asked for payment ‘upfront’ before we started work on an order.

How Credit Checks Can Work For You

Decide now how you will credit check all new clients before accepting the first order.

If this seems difficult, think how difficult it will be if your new customer doesn’t pay!

Once you know that their payment track-record is good, and you make sure they pay their first invoice on time, you’ll be doing your best to avoid costly bad debts.

To your business success!